Explained: Why global oil prices are falling and is it good for India?

Apr 21, 2020

It has been a season of surprising swings in the global economy, but nothing compares to the plummeting value of global crude oil prices.

Oil became the buzzword overnight as benchmark US crude prices crashed below $0 for the first time in history on Monday, throwing investors around the world off guard.

Shares of energy and oil firms bled on stock markets around the world as experts predict a global energy glut in the wake of suspended economy activity due to Covid-19 pandemic.

US’s benchmark index for crude oil, WTI crude or West Texas Intermediate Crude, plummeted to minus 37.63 dollars. It created an unprecedented situation where sellers paid buyers to take deliveries.

While WTI crude futures for May clawed back some ground, the price stands at minus $4.6 per barrel at the time of writing this article. The sheer volatility due to lack of demand could again lead to a drastic fall in global crude oil prices.

The demand for the commodity is so low at the moment that oil-producing countries are running out space to store crude and may have to look at further cuts if demand outlook does not improve.

This, despite the recent agreement between Organisation of the Petroleum Exporting Countries (OPEC) and its allies to cut production by a historic 9.7 million barrels per day.

Low demand makes oil ‘worthless’

The supply of fuel has exceeded demand by a huge margin since Covid-19 pandemic led to the showdown of key economic activities around the world. Experts say if demand does not improve it will become a “worthless” commodity.

In the US, the storage tanks for WTI are almost filled to the brim and there is literally no space to store more.

A Reuters report stated that the US Energy Administration announced last week that the oil storage facility at Cushing, Oklahoma, was about 72 per cent full as of April 10.

Bob Yawger, director of futures at Mizuho in New York, told the publication that the price of the commodity is effectively worthless if there is no available storage anymore.

“So when it’s minus a dollar, they’ll pay you a dollar to get it out of there,” he said.

Understanding oil trade and futures contracts

All of the world’s oil trade happens through contracts. Since oil is one of the most popular commodities around the globe, oil futures contracts are also traded on futures exchanges just like shares.

Such contracts are legal agreements between buyers and sellers, binding them to buy and receive a certain quantity (in barrels) of oil when the contract expires.

What happened in the US’s case was that May futures contracts plummeted sharply – more than 100 per cent – right ahead of their expiry on Tuesday. It is worth noting that each contract trades for a month before expiry.

But investors who held May contracts did not want to take delivery of oil and incur additional storage costs. They literally paid people to escape the conundrum.

But the situation is not so bad with respect to other benchmark oil indexes. Brent Crude Oil Futures are just below 25 dollars after a 3.6 per cent fall. This is not as bad in comparison to WTI futures contracts for May.

Moreover, WTI Crude Contracts for June, which has seen more active trade, is trading over 21 dollars. The July contract was also trading over 26 dollars.

While these offer a better reflection of US oil trade, it will depend on whether demand for the commodity rises in the new future.

Simply put, if oil demand remains at the current level or falls due to suspended economic activity, a glut in oil production could further hurt global oil trade. However, there are increased hopes of resumption of economic activity around the world starting before the June futures expiry.

But experts say it is too early to predict given the Covid-19 situation.

It is worth mentioning that that Covid-19 has disrupted daily demand of nearly 30 million barrels per day, which is 30 per cent of the global demand. This massive quantity has been parked in storage facility worldwide for the past few months.

Global analysts said it would take a long time to burn off so much crude and this will create a looping demand-supply issue for a longer period.

Kevin Flanagan, head of fixed income strategy for Wisdomtree Asset Management, told Reuters that the demand is coming back anytime soon.

“What the energy market is telling you is that demand isn’t coming back any time soon, and there’s a supply glut,” he said.

Does India benefit?

No. India does not benefit from falling global crude oil prices. And petrol and diesel prices will not go down any time soon.

The Indian Basket is a weighted average of Oman, Dubai, Brent Crude, is an indicator of the price of Indian crude oil imports. It is currently at $20.56 per barrel, sharply lower than levels seen before.

However, India does not benefit much from lower oil prices at the moment, especially as the entire nation has been kept under lockdown. With hardly any demand for oil, India already has its tanks full.

Therefore, despite better prices on offer, India is likely to refrain from buying any oil. So, if India buys oil during this period, it could save a few bucks but a weaker currency will ensure that it spends comparatively more.

The rupee is currently trading at 76.70 per US dollar.

Lower crude oil prices do not even promise any benefit consumers in the short run. Petrol and diesel prices are unlikely to come down as a large portion of these prices are made up of government taxes.

To sum it up, the prices on offer are lucrative for India but the pumps are full across the country due to lack of demand. The situation is the same around the globe.

If the global lockdown continues for a few more months, global oil producers could be left in a pool of trouble.

TL

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